Mortgage Rate Outlook

Mixed signals from Canadian economic data are making the outlook for the Canadian economy somewhat cloudy. While labour markets remain very strong, economic growth appears to have stalled in the fourth quarter of 2022. Most importantly, the monthly inflation rate has significantly decreased, although it still remains high when compared to the previous year, with total CPI trending at 2.5% annually over the past three months and core measures of inflation trending at between 2.5% and 3.5%.

That mixed data has led to uncertainty about the economy’s direction, which has expressed itself as significant volatility in bond yields as financial markets grasp for clues on future monetary policy decisions. Movements in bond yields that used to be relatively rare have become commonplace. Since 2007, the five-year benchmark bond yield has risen or fallen by ten basis points in a day just 5% of the time. Since 2022, ten basis point moves are occurring 20% of the time – or roughly every five trading days.

Moreover, of the 18 times since 2007 that the five-year yield has changed by 20 basis points in a day, 30% of those occurrences have happened in just the past year. In just the week, volatility in bond markets increased even further when the failure of Silicon Valley Bank caused a flight to safety, pushing down US and Canadian long-term interest rates once again. During the past three months, the five-year bond yield rose from 2.8% to nearly 3.7% before falling to under 3%. Our baseline is still for a sub-5% five-year fixed mortgage rate by the end of the year, but clearly, there will be much volatility on the journey there.

As long as the Bank of Canada remains on hold, and fixed rates experience only minor increases, the uncommon scenario of a notable negative difference between variable and fixed rates will persist.

Economic Outlook

Growth in the fourth quarter of 2022 was nearly unchanged from the prior quarter, following five consecutive quarters of growth and real GDP declined in the final month of the year. Declines in business inventories and business investment balanced out higher consumer and government spending and more favorable net trade. Higher interest rates are clearly impacting the most rate-sensitive sectors of the economy. Housing investment fell 2.3% in the fourth quarter and was down 11.1% in 2022. As tighter borrowing conditions impact the wider economy, we anticipate that growth will slow, and the labour market will soften.

The open question for the economy remains whether a recession is likely to occur this year. Given the pace and magnitude of tightening by the Bank of Canada, and signals from traditional recession warning tools like the slope of the yield curve, the recession probability is high. Our model shows two quarters of negative GDP growth starting in the second quarter before a recovery begins toward the end of 2024.

A complicating factor of course, is the trajectory for inflation. Any economic recovery is contingent on interest rates coming down sharply from their current level, which will not occur unless inflation is back under control.

Bank of Canada Outlook

The Bank of Canada has moved to the sidelines while it judges the past year’s impact of rate increases on the economy, particularly on inflation. Several factors point to inflation beginning to normalize this year. Barring a significant shift, gas prices will start to subtract from yearover- year CPI inflation. Additionally, raw materials and shipping costs should benefit from a downtrend in global commodity prices and a normalization of supply chains.

One complicating factor for the Bank of Canada is the potential for a more hawkish US Federal Reserve. A widening gap between Canadian and US interest rates would put downward pressure on the Canadian dollar, which would cause import prices to rise, adding to Canadian inflation.

Nonetheless, we expect the Bank will remain on hold this year before lowering rates in 2024 once inflation returns to its target of 2%.

Mortgage Rate Forecast (March 2023) by Brendon Ogmundson | Chief Economist | BCREA